OBR shows how austerity killed growth

The OBR published a short note last week showing the impact on growth from the fiscal decisions taken by the Coalition Government. This is not a revelation. The OBR has said before that austerity would have and has had a negative impact on growth, but the chart it produced with this note is quite striking. Here’s the chart.Screenshot 2015-10-27 at 6.13.47 PM

It shows that following the crash, Labour’s discretionary fiscal policy (that’s active changes to government spending and taxation) had a positive impact on growth of around 0.3% in 2008/9 and 2009/10. Labour enacted a fiscal stimulus, but not a very big one.

It’s what this chart shows about the period after the 2010 election though that’s most interesting. After assuming power in 2010, the Coalition embarked on it’s policy of austerity. When it was formed, the OBR actually thought austerity in the first year would have a bigger negative impact than it in fact did, but it still provided a drag on growth of about 1% in 2010/11. 2011/12 was actually the year when austerity really started to kick in. When the OBR made it’s first forecasts though, it thought austerity would have a negative impact on growth of around 0.6%. In actual fact though, it was more like 1%.

It’s fairly well known now that despite the rhetoric, George Osborne actually responded to terrible growth figures in 2011 and 2012 by easing up on austerity, and this can be seen clearly in the chart above. In 2012/13, the government’s discretionary fiscal policy had a very small negative impact on growth, turning to a very small positive impact in 2013/14.

In 2014/15 though, the year before the election (coincidentally I’m sure), George Osborne’s discretionary fiscal policy made a positive contribution to growth of over 0.3%, which is more than Labour’s stimulus provided after the crash. So growth is only at the level it is now because of the positive impact of fiscal policy, something that many Conservatives don’t want to hear.

We are to believe that more cuts are on the way as Osborne tries to achieve a surplus by 2019/20, but if he goes ahead with the cuts implied by his plans – tax credits being only one part of it – it seems likely this negative drag will continue. Coupled with prospects for growth in the rest of the world looking bleak, it seems unlikely that growth can persist alongside spending cuts. Something will have to give.

What Cameron’s idea of “living within our means” actually means

Bill Mitchell’s blog post from today on David Cameron’s recent speech on the economy was a good one. Bill writes:

The Government then proposes the following nonsensical fiscal cut back over the next five years. Obviously, some genius in the Treasury (or OBR) has been told that they have to get a surplus by 2018-19 and then drew the spending cut line to meet that objective.

If that net public spending contraction was to happen given the state of the external sector and the already heavily indebted private domestic sector, then pigs would be flying or the economy would be pushed back into deep recession.

The problem is that if they really try to cut spending by that much and that quickly then the recession will come before the pigs take-off.

UK_fiscal_contraction_2018_19

The House of Commons yesterday overwhelmingly voted to commit to achieve budget outcomes in this ballpark. Bill thinks pigs will fly before this is achieved! He goes on to take a look back at some OBR reports from 2011 (including this one) to have a look at what was being forecast for private debt at the same time as politicians were talking solemnly about the need to reduce debt as our responsibility to future generations. Bill says:

The following Table is taken from the OBRs Table 1 showed the forecasts for household assets and liabilities as a percentage of disposable income. The OBR says that “net worth is forecast to decline as a percentage of income as the household debt ratio is expected to rise and the household assets ratio is expected to fall”.

In other words, all the fuss about private and public debt levels and “dealing with our debts” in 2010 and 2011 was a smokescreen.

Its own growth strategy was always contingent on the private sector taking on a rising debt burden over the forecast period and becoming relatively poorer?

What the British government’s strategy amounted to was a deliberate plan to reduce public debt at the expense of more private debt.

Prudent fiscal management requires that exactly the opposite is the case when the economy is floundering – given current conventions about matching fiscal deficits with public debt issuance.

So which part of Britain is actually “living within its means”?

It’s a good question! In the event, household debt hasn’t (yet) gone up by as much as forecast because the government’s deficit hasn’t come down by anything like as much as was thought, but rising private debt is an absolute guarantee should politicians like George Osborne get their way. Here is the path the OBR are currently forecasting:

US_OBR_HH_debt_income_2020

In other words, above the levels of the 2008 crisis. Bill ends on a rather depressing (but probably accurate) note:

It is clear what ground the British election will be fought on in the coming months. Economic myths, data denials and lots of well-crafted myths about money, debt and deficits.

The real problem is that the British Opposition will go along with it and claim it will conduct austerity better and more fairly and all the rest of the nonsense.

OBR doesn’t appear to understand the implications of its own forecasts

Head of the OBR, Robert Chote was questioned on the Autumn Statement by the Treasury Select Committee yesterday. The full transcript is here, but I don’t recommend it unless you are having trouble sleeping. I blogged last week about the OBR’s forecasts and what they imply about household debt, but this didn’t come up much at all yesterday. The only point at which it did was when Conservative MP Steve Baker asked:

“Can I just tie some of this into what we heard yesterday from some of the economists from the City who came in? I had an exchange with them about this notion that savings are being run down and that consumer credit is coming forward, and we agreed that this is demand being brought forward. So if demand is being brought forward today, through the rundown of savings and the taking up of consumer credit, wouldn’t we expect a reduction of demand in the future and wouldn’t this lead us into a further boom/bust cycle, even within the context of how you think about demand?”

So Baker is saying consumers are spending money today, not because of rising incomes but because they are spending their savings or borrowing for consumption. He asks how long this can continue. Here is Robert Chote’s reply:

“Certainly if you look at the relatively robust pace of growth over recent quarters, that has been reflected particularly in terms of the contribution from the consumer of people running down savings rather than having stronger income growth. We have assumed that it is not plausible, and I think if you look at the last year the real consumption growth has been running further ahead of real wage growth than in almost any other year over the last 15 or 20 or so. Therefore, in our forecast, the main reason we expect the quarterly pace of growth to slow into next year is that you see consumer spending moving more into line with income growth and being less driven by the sort of decline in saving you are talking about.”

So Chote is  saying the potential for the trend of consumer spending being supported by running down savings and consumer debt continuing is not plausible, but that they expect wages to pick up which will ensure spending growth continues (albeit at a slower rate). The thing is though, as I outlined in the two posts linked to above, in order for the deficit to be eliminated over the next 4 or five years, that’s exactly what the OBR are forecasting needs to happen. Household debt needs to rise and consumers need to spend more than income on an unprecedented scale. So either Chote doesn’t understand the implications of his own forecasts, or it’s his way of saying they are just ‘not plausible’. It’s a shame none of the MPs present pushed him more on this.

Public borrowing bad, household borrowing good?

Following on from yesterday’s post about the unspoken assumptions needed to get us to a budget surplus by 2019, here’s another chart from the OBR’s report on the Autumn Statement:

It shows the ratio of household debt to GDP. This peaked just prior to the crash in 2008 at around 170% of GDP after which time, households started to ‘deleverage’ and the ratio fell to around 145% today. For the reasons I gave in yesterday’s post, in order for the government’s deficit to disappear and then go into surplus, household borrowing will have to rise. The OBR forecast it will rise to over 180% of GDP by 2020. Remember that the crash coincided with a ratio of just under 170%, but it is now assumed we can go way beyond that seemingly without any problems.

I have hardly seen this mentioned in the commentary surrounding the Autumn Statement, but it’s a huge elephant in the room. If public debt is such an evil, burdening our grandkids for years to come, why is household debt (where the interest rates will be much higher) not similarly bad? I would suggest that rising household debt presents a much greater systemic risk to the economy than government debt, and no Chancellor with a serious #longtermeconomicplan would put rising household debt at it’s centre. It’s seriously unwise and is setting a timebomb waiting to go off. I reckon Osborne realises the chances of a Tory Government next May are pretty slim, so doesn’t really care what problems he is creating if it means he can retain his reputation for ‘fiscal responsibility’ and someone who can take ‘tough decisions in the national interest’.

All the media comment has been around marginal changes like on stamp duty or on the nightmare of cuts still to come, but to me this issue of household debt is one journalists should be hammering away at hard. We need to be asking if replacing government deficits with household deficits is another other than a recipe for disaster.

Osborne plans to deliver his surplus on the back of rising household debt

George Osborne delivered his Autumn Statement today (in winter!), setting out the outlook for the economy over the next 5 years. He is quite a ‘clever’ politician, so you don’t really learn a lot from listening to his speech as he changes definitions and context so best to suit his narrative. The figures he quotes though are produced by the OBR, which you can download for yourself here.

I’m not going to say anything about his speech, but rather focus on the ‘quest for a budget surplus’ as I’ve decided to call it. All parties seem to be on this quest, so I thought it might be worth setting out what assumptions need to be made in order to get us to a surplus by 2019. To do this, I’m using the OBR’s forecasts for the UK economy’s ‘Financial Balances by Sector’ found in table 1.10 from the spreadsheet Economic and fiscal outlook supplementary economy tables – December 2014.

Although people do so all the time, it’s not really possible to discuss the government’s deficit in isolation, because there is an accounting identity which means the government’s deficit (or surplus) is equal to the non-government’s surplus (or deficit). You can disaggregate ‘non-government’ in a number of ways, but the OBR break it down into ‘households’, the ‘corporate’ sector and ‘rest of world’ (which to simplify, we can think of as the trade balance).

Here are the figures the OBR put out today put into a chart. The bars up to 2013/14 are actual data, and the bars beyond are their forecasts for the next 6 years. The green bar is the government’s budget balance. You can see that in 2009/10, the deficit was over 10% of GDP, and the OBR forecast it will be eliminated by 2018/19 when there will be a small surplus.

Financial Balances

How will we get there though? In the year just gone (2013/14), the government’s deficit came in at 5.6%. The non-government balance was comprised of a 0.1% household ‘deficit’, a 0.9% corporate ‘surplus’ and a trade deficit of 4.4% (this should sum to 5.6% but doesn’t because, as the OBR explain, there is a ‘residual error’ – this case 0.4%). The chart above shows the green bar shrinking over the years, but what is changing in the other sectors at the same time?

At the moment we have a rather large trade deficit of almost 5% of GDP. The OBR are forecasting this will be cut in half over the next 5 years. Is this likely? They are also forecasting world GDP growth to slow down over the next few years, so the prospect for UK exports may not be that rosy.

The blue bar on the chart is increasing quite significantly out to 2019/20. This is the household balance, and it is forecast to be in deficit going forward. That means the OBR expect households to spend more than they earn (in aggregate) year on year. How likely is this to come about? To give some context, we can look at what the household sector’s balance was in previous years to see how feasible an outcome of a 3% household deficit might be. The figures going back to 1997 are contained in this post on Neil Wilson’s blog. Neil’s second chart shows that in the run up to the financial crisis (from about 2004 onwards), households ran a small deficit of between 0% and 2%. This contributed (partly) to the biggest crash in over half a century, but for the OBR’s forecasts to work out households would have to run deficits about double (or more) this level year after year. Is this even possible without causing another recession before we get to 2020? I don’t see how it is. This chart from the OBR’s full report also shows the full picture since 2000 clearly. The required rise in household debt is unprecedented in recent times.

net lending

The ‘quest’ seems like pie in the sky stuff to me, and dangerous stuff at that. When it became clear Osborne would miss his targets after 2010, he eased up. Hopefully, whoever wins next year, will quickly realise what a fools errand the quest is and do the same. Pumping up household debt to dangerous level is not a sustainable longtermeconomicplan!

Last 7 Days Reading List 07/12/13

Mostly stuff on the economy this week. First up, I liked this post from Think Left, which includes some nice quotes and a video promoting MMT:

Why do politicians tell us debt/deficit myths which they know to be untrue?

Neoliberal news now, and Guardian columnist George Monbiot informs us about the US/EU trade deal about which I was previously only dimly aware. It doesn’t sound good:

The lies behind this transatlantic trade deal

One of the positive pieces of economic news over the last year has been the increase in employment. The Tories have been trumpeting this with hilarious charts like this (what scale are they using here):employment

Beneath the headline though, what’s less certain is about the type of employment being created. Self-employment for example has risen quite sharply in recent years, but much of it seems to be quite poorly paid, and as a result, self-employed worker’s earnings have been falling:

Self-employed worker’s earnings slump by nearly a third

And in related news, Communities Secretary Eric Pickles has been boasting about how many families have been ‘turned around’ by his troubled families programme. The definition of turned around seems as vague as the original definition of troubled families was. Turned around doesn’t seem to include finding work though as this story from my local paper describes:

Government jobs scheme gets jobs for just three in Bradford

On to the autumn statement now, and I liked this blog on George Osborne’s stated desire to run a budget surplus:

Why do the British enjoy committing economic suicide?

The economy does seem to be recovery though, although the OBR say they expect it to slow down somewhat next year. George Osborne vindicated? The FT’s Martin Wolf thinks not (must register to view):

Autumn Statement 2013: Britain’s needlessly slow recovery

And as long as we keep seeing stories like this, any claims of recovery must be dismissed:

Bradford food bank makes urgent ‘help’ plea

Moving on again with the news of Nelson Mandela’s death at the age of 95. I was only 8 when Mandela was released from prison, and I think a lot of people of my generation don’t know much about his life before that point, and how he was viewed by different people. A lot of rewriting of history seems to be going on and I thought this blog was interesting in its perspective:

They come to bury Nelson, not just to praise him

Finally, on a lighter note, the news that Amazon has been trialing drone deliveiesI thought this mocked-up Amazon calling card was well done:

Drone

What Most Discussions of the Deficit are Missing

This post will attempt to explain a concept in economics known as “sectoral balances”. This might get a bit wonkish, but hopefully not too much.

We hear a lot about the Government’s debt and deficit, how it is too high and must be reduced even at the expense of jobs and living standards. What we rarely, if ever hear about though is the other side of the ledger – the private sector. Here’s an example of what I mean:

ukgs_line

Here’s a chart of UK Government debt. It’s risen from around 40% of GDP 25 years ago, to a little under 70% in 2012. A pretty big rise huh? But what about private sector debt?*

private debt

25 years ago, total private sector debt was just under 150% of GDP, but by the time the 2008/9 crisis hit, this had more than trebled to over 450%. While the debt households and non-financial companies increased significantly over the period (doubling and trebling respectively), the main culprit was the financial sector, who’s debt peaked at 258% of GDP in Q1 2010. Looking at the two charts above, which problem looks more urgent? But yet the focus on the government’s finances is relentless.

Look again at the second chart, and you’ll see that following the crash, all three parts of the private sector started to reduce their debts, although this year that trend seems to have paused. This is what is known as deleveraging – paying down debt. Economists like Richard Koo have labelled this period of deleveraging a “balance sheet recession“. Basically, when asset prices collapse following the bursting of a bubble, millions of private sector entities find themselves in dire straits, so they all simultaneously attempt to increase savings or pay down debt at the same time, causing a collapse in economic activity.

Now back in 2011, David Cameron drew the ire of some economists when a speech he was about to make reportedly contained the lines:

“the only way out of a debt crisis is to deal with your debts. That means households – all of us – paying off the credit card and store card bills”.

Now Cameron’s problem wasn’t the advice per se, (it’s probably a good idea for households in too much debt to cut back) his problem was that he’d forgotten the economics he’d learned while studying PPE at Oxford, namely Keynes’ Paradox of Thrift. While for an individual, saving or paying down debt may be a sensible thing to do, because my spending is your income and vice versa, if everyone tries to do it at the same time, total savings will actually fall. This allows me finally to get to the point of this post.

While the government’s deficit is always discussed, what is never discussed it that the government’s deficit is equal to the surplus of the private sector. The approach of examining changes in the economy by looking at different sectors in the economy is known as the sectoral balances approach, which was popularised by British economist, the late Wynne Godley. It highlights the accounting tautology that shows:

Private Balance = Government Balance + Trade Balance

The private balance is private savings minus private investment spending, the government balance is government spending minus tax receipts and the trade balance is exports minus imports. This equation is always true whether there is a government deficit, surplus or balanced budget. Here you can see a graphical representation* by way of illustration using real data for the UK.

sectoral balances

In this chart, the red bars represent the capital account which is equal but inverse to the trade balance (or current account to be more precise). This just helps to show more clearly how the governments budget position mirrors the position of the non-government sector. So, in the latest quarter, a 5% private sector surplus and a 3% capital account surplus is offset by an 8% deficit.

The point of showing this is to say that the government cannot really have a budget deficit target and hit it because it depends upon what happens in the other two sectors. When Cameron says he thinks households should pay down debts, he doesn’t realise that its impossible for both the government and the private sector to do that at the same time, unless the country has a very sizable trade surplus (which we certainly don’t have). The government can either accommodate the private sector’s desire to pay down debt/save by increasing spending/cutting taxes, or it can try to cut its own spending and at the same time hope households and businesses will be willing to take on more debt.

In a sane world, the government would realise that the first option is preferable, but instead it has plumped for option 2. If you look at the figures produced by the OBR**, you can actually see that deficit reduction is predicated on households going into deficit again. This cannot be a sensible strategy. The problem the government has is that while it can control some portion of its budget, it can’t control other parts like the welfare bill, and it can’t control how much tax it takes in. These things are determined by saving and investment decisions made by the private sector and the performance of exports over imports. Once this is understood, it’s clear to see how commentators like Fraser Nelson are misguided when they say there are no cuts because spending is going up. The government are making cuts, its just that those cuts are causing other parts of the budget (parts they have no control over) to go up.

The sectoral balances approach then allows us to consider how changes in government policy may impact upon the different sectors. Armed with this knowledge you would know that for the government deficit to go down, the private surplus and/or the trade deficit would need to shrink or disappear entirely. At a time of global recession, the prospects for a massively shrinking trade deficit don’t seem good, and the prospects for an already debt-saturated private sector to take on yet more debt also seem less than positive. Both of these things imply that any attempt to reduce the government’s deficit by cutting spending or raising taxes will ultimately be futile, and that’s exactly what we are seeing at the moment.

Here then are the key take away point from this post:

  • Outstanding private debt dwarfs government debt, both as a % of GDP and in the extent to which it is a problem that needs dealing with.
  • Considering the government deficit in isolation leads to wrong-headed policy making. Policy-making should take account of all sectors of the economy when considering the implications of different policy options.
  • The three sectors must balance. In a trade deficit nation like the UK, if the private sector is saving/paying down debt, a government deficit is inevitable regardless of the government’s spending plans. Any attempt by the government to cut it’s deficit will fail unless the private sector is willing to cut its surplus/run a deficit.
  • Those who argue austerity is not happening do not understand the points above and don’t get the ‘tyranny of the accounting’.

* The second and third charts in this post have been taken from this excellent blog. The blog’s author Neil Wilson updates these charts on a quarterly basis as new data is published. Here is the post the charts are taken from.

** The OBR publishes forecasts for what they think will happen to the sectoral balances (they call them financial balances) here (Its the supplementary fiscal tables, tab 1.8).

OBR Chairman Kills Rationale for Austerity in 1 Minute

Yesterday, OBR Chairman Robert Chote appeared before the Treasury Select Committee to discuss the OBR’s forecasts for the Autumn Statement. About an hour in, Conservative MP Brooks Newmark asked Chote what would happen if Britain lost it’s AAA credit rating. Remember that for the last 2 and a half years, George Osborne has based his whole economic strategy upon preserving our AAA rating – to lose it would apparently mean higher interest rates, less investment, lost jobs. But here’s Robert Chote responding to Newmark:

“Well it’s not entirely clear that that [a downgrade] would be providing any new information to the markets that they hadn’t already managed to deduce I think from the information on which presumably the credit ratings agencies would have drawn their conclusions. I think we’ve seen other countries suffer that, and it’s not had an obviously noticeable impact on market views. Obviously, the notion of how sensible it is to view this as a change in default risk, when the notion of default risk for a country that basically can print its own currency, is a slightly debatable premise to begin with.

Here’s the video. The relevant bit starts at 10:31:30:

http://www.parliamentlive.tv/Main/Player.aspx?meetingId=12062

A downgrade of our credit rating downgrade now looks inevitable and apparently Osborne’s colleagues in the Cabinet are urging him to do a 180 and start downplaying the consequences of a downgrade.

The way this story is changing reminds me a bit of the last Labour Government’s changing story on the invasion of Iraq. First they attempt to scare us into accepting some awful policy (WMDs or Greek style bankruptcy), then they change it to a story about human rights (or now, changing the ‘benefits’ culture). Finally, once the policy is embedded, the story becomes “If we turn back now it would be a disaster”.

So from Robert Chote, we now know losing our AAA rating probably won’t much effect interest rates. We know the mantra “There’s no money left” is idiotic (we have our own currency). We also know that changing course would not lead to disaster as Osborne contends. At the end of the video, Chote also says that an increase in Government borrowing wouldn’t necessarily have any impact upon market expectations either. So what rationale for persisting with austerity remains?